Collective Action Clauses (CAC’s henceforth) or
Majority Action Clause have a long and varied history. According to Buchheit
& Gulati[1]
they were first introduced in English law by Palmer (1879). Their introduction
served and serves a very real purpose and need. That of facilitating the restructuring
or the amendment the (T)erms & (C)onditions of a Bond by the majority of
Noteholders and to avoid rogue or malevolent holders of bonds holding at ransom
both the debtor and other creditors. What
are CAC’s (see Appendix for an example) and what purpose do they serve? Let me start with an example of how it might
work.
Suppose that ACME
a company that manufactures futuristic technology gadgets finds itself in the
position of having a severe cashflow problem as one of its major clients Mr W.E.Coyote
has not paid in time. ACME is unable to pay its bond liabilities at the agreed
time. Consider further that most bondholders believe, after careful analysis of
ACME’s product range, that the main
business is sound and given time and perhaps some reorganization of the company’s
management and client focus ACME
would thrive and pay in full its bond liabilities. All that it needs is to amend
some of the T&C of the bond, perhaps extend the maturity or move some
coupons in the future and ACME would
survive. One bondholder, Mrs R.Runner for reasons of personal benefit or other,
things differently. When ACME got
into trouble Mrs Runner bought some of the bonds at discount with a view to either
force ACME into liquidation or force
a management change or simply to extract more money. Mrs Runner can do so since
ACME bonds need the consent of 100%
of Noteholders as there are no CAC’s that allow for the will of the majority to
prevail. If on the other hand, ACME
bonds included right from the start CAC’s specifying that a 75% majority is
binding for all bondholders Mrs Runner would have needed at least 25% of the
outstanding ACME bonds to see her sinister plans materialize.
As always, however, there is another side to the ACME story. It could be that the real
villain is ACME and the victim is the
unsuspecting small bondholder. ACME
purposefully, introduced (at the start) CAC’s with a low majority threshold,
say 50% (simple majority) with a view to make non-payment or restructuring fast
and easy. ACME colluded with some
bondholders to haircut the bond’s principal by 50%. Then ACME found some other way to compensate (recapitalize or sweeten)
its friendly creditors.
Thus, CAC’s have two sides. Striking a balance between
the real need to restructure a company and with the moral hazard it introduces
is a fine art. Ultimately, any dispute in the motives would have to be resolved
by courts. In fact, there have been cases where the majority has been
overturned as it was not deemed to serve the interests of all bondholders. This
means that even though CAC’s allow for the majority view to prevail, the
minority bondholders cannot be ignored completely. After all, the original bond
documentation contains an “unconditional promise to pay”.
One argument against the introduction of CAC’s in the
bond documentation has to do with price and liquidity. Studies have concluded that
the introduction of CAC’s in less creditworthy countries (lower rating) have an
adverse effect on the price and liquidity. Namely, creditors demand a higher
yield as they view the CAC’s from the moral hazard point of view. For borrowers
of high rating CAC’s are viewed as a safety feature.
Europe and the
Greek Case
One has to note that while in the case of corporates
all countries have laws dealing with bankruptcy (Chapter 11 in US etc) the
equivalent for sovereigns does not exist. There have been various attempts by
IMF and others to formalize the process with various degrees of success. Introducing
CAC’s is one way to ease and facilitate the speedy resolution of debt
restructurings. It is for this reason the European Finance Committee[2]
(EFC) in Europe welcome in April 2003 the implementation of CAC[3]
in European Bond issuance. The Chairman of that committee was none other than
Prof. Christodoulakis the then Greek Finance minister.
It may not come as a surprise that Greece never
implemented CAC’s in its domestic bond issuance despite the apparent
endorsement of the Greek Finance minister.
If it had done so back in 2003 things would be very-very different now
for Greece; for the better. In fact, Greece is the only country alongside Italy
that it did NOT implement CAC’s in their domestic bond issuance. Italy’s formal
claim was that it would affect the price and liquidity of its bonds. We do not
know the reasons of the Greek non-compliance (after all the Chairman of the EFC
was Greek!).
PSI and Greek
Bonds
One can divide the Greek debt into two classes; those
that are issued under Greek law (ISIN starts with GR….) and those that are
issued under foreign law. Before the Greek bailout and the bilateral loans to
Greece, around 90% of the Greek debt was under Greek law and jurisdiction. This
percentage together with the advantage it conveyed to Greece is been eroded, as
all the bailout loans are under English law. In fact, most of the Greek foreign law bonds
are under English law and all of them contain some form of CAC’s. Some[4]
require a 2/3 (66 2/3) majority while others[5]
have a 75%. Even though restructuring these bonds is easier as they contain CAC’s
they also offer much higher protection to the bond holders and as such they are
traded at a premium to the Greek domestic bonds. This is because they also
contain “Negative pledge” and “moratorium” clauses and also because any dispute
would be decided in London and not in Athens courts. In fact some contain very poisonous
clauses and it is a source of puzzlement why the Greek government has not
attempted to obtain the requisite majority to either change these clauses or
destroy the bonds.
For the Greek domestic bonds things are different. As
mentioned above the Greek domestic bonds do not contain CAC’s and thus any restructuring that aims to avoid a Credit
Event (Default) would require the consent of all bondholders. It is for
this reason that the PSI was declared to be a voluntary proposal. Trying to
secure a high participation was left to the gentle persuasion of politics and
incentives. For an analysis of the current state of the PSI read “Should
Santa bring PSI to the Greeks” (and in Greek here).
Should Greece
introduce CAC’s to force PSI?
As it turned out, however, bondholders were not
adequately incentivized to participate in the voluntary loss of more than half
of their investment. In fact, the largest bondholder, the ECB, has flatly
rejected any talk of participating in the PSI. Other bondholders see that as an
opportunity to join the free ride (See “The
thrills and joys of free-riding”).
It comes as no surprise that according to Greek press
reports the Greek government is considering introducing CAC’s to force the
holdouts to participate in the PSI.
Here we ask the question: “Is it prudent for Greece to do
so? What are the pros and cons of such an action?
Let’s assume that Greece manages to come to some form
of common ground with the IIF (representing the bondholders) and a bond swap is
on offer. Namely, holders of the Greek bonds would tender their holdings and in
return they would get some New Greek bonds and perhaps some cash. Assume
further that only 65% participation is achieved. Greece being a sovereign state
has the power to legislate at that point, that once the offer has been accepted
by 65% it is binding for the rest 35%. It can further legislate that small (up
to 100,000) private bondholders are immune. Greece certainly has the power to
do it, but doing so is an event of default. This is because Greece
changes unilaterally the Terms of already existing bonds to the detriment of
the bondholders. This is where things get more complicated. Under the voluntary
offer Greece would assume the status of “Selective Default” which is not really
a default as it describes the period between making an offer and the acceptance
of this offer. Now, however, the Greek government has caused a full blown
default. It goes without saying that CDS’s would be activated, but this is only
a political concern and not an economic. The outstanding net CDS volume is far
too low to have any impact (around 3billion). The objection to the CDS comes
mainly from ignorant or populist politicians. The main problem would come from
Greece being placed under default and the litigation it would trigger. Furthermore
it cannot discriminate in favour of the ECB. The ECB would have to oblige to
the will of the Greek CACs. It also sets a very dangerous and unwelcome
precedence for all bondholders of European debt. Holders of debt of third world
countries factor in such a behavior when it comes to investing in their bonds.
They do not expect this kind of behavior from European Union country. This
would alter the perceptions, pricing and dynamics of European debt for many
years. If on top, Greece discriminates positively against the official sector
(ECB) it would deal a further blow to the credibility of the EU and its
practices. Last but not least, Greece would enter a period of prolonged legal
battles with disgruntled bondholders. This is paradise for the law firms who
advice Greece as it would mean many years of high legal fees. Despite the fact
that it would be difficult for bondholders to attach any Greek assets to their
claims they can make life for the Greek government very difficult and possibly
prohibit Greece from entering the international capital markets for many years
unless Greece settles their claims.
In summary, introducing CAC’s to force the PSI would:
- Be a credit default event. One cannot see the logic of having a credit event just for participation in the PSI. It is like using a sledgehammer to kill a fly. If Greece decides to go down that route, they might as well legislate that all bonds become zero coupon.
- Greece would have to have the financial support and consent of the ECB and EU. Otherwise it would not survive the financial repercussions of an event of default.
- Trigger CDS
- ECB would have to take losses and possibly go bankrupt unless the Greek government positively discriminates the official sector and possibly small private owners. This would be a particularly bad precedent for Europe and would for sure be challenged by other bondholders.
- Greece would engage into hard and long legal battles as bondholders challenge this.Reputation of Greece as a debtor would be severely affected because of its behavior.
- Reputation of EU would also be affected as this is not what creditors expect from a member of the Union.
- Greece would set a very bad precedent for other European countries. The market would price accordingly other peripheral bonds.
- Greece would still need to borrow money to pay the coupons of the new PSI bonds. Estimates vary between 6 and 8 billion. As Greece is running a primary deficit it would need to access the markets or turn to the IMF/EU once more.
It is thus very hard to find anything positive to say
about such an action. In fact the only beneficiaries of such an action would be
the lawyers that advise Greece and would be defending Greece for many years
with high fees. It would be a gross mistake for Greece and Europe to follow
that path. Let us hope that the press
reports are just empty threats aimed at naïve bondholders because the serious
ones are already honing their battle axes and Greece is no match for them.
Appendix A. Example of CAC from Greek Bond
XS0357333029
MEETINGS OF NOTEHOLDERS AND MODIFICATION
The Agency Agreement contains provisions for convening meetings of Noteholders
to consider matters affecting their interests, including modification by Extraordinary
Resolution of these Terms and Conditions or the provisions of the Agency
Agreement. Such a meeting may be convened by the Republic and shall be convened
by the Republic at any time upon the request in writing of the holder or holders
of ten per cent. or more in principal amount of the Notes for the time being outstanding.
The quorum for any meeting convened to consider an Extraordinary Resolution
shall be one or more persons holding or representing not less than 66 2/3 per
cent. of the aggregate principal amount of the Notes for the time being outstanding,
or 25 per cent. of the aggregate principal amount of the Notes for the time
being outstanding at any adjourned meeting. However, at any meeting, the business
of which is to: (i) change the due date for the payment of the principal,
premium (if any) or any installment of interest on the Notes;
(ii) reduce or cancel the principal amount or redemption price or
premium (if any) of the Notes;
(iii) reduce the portion of the principal amount which is payable upon
acceleration
f the maturity of the Notes;
(iv) reduce the interest rate on the Notes or any premium payable upon
redemption of the Notes;
(v) change the currency in which interest, premium (if any) or principal
will be paid or the places at which interest, premium (if any) or principal of
Notes is payable;
(vi) shorten the period during which the Republic is not permitted to
redeem Notes, or permit the Republic to redeem Notes if, prior to such action,
the Republic is not permitted to do so;
(vii) reduce the proportion of the principal amount of the Notes whose
vote or consent is necessary to modify, amend or supplement the Agency
Agreement or the Terms and Conditions of the Notes;
(viii) reduce the proportion of the principal amount of the Notes whose
vote or consent is necessary to make, take or give any request, demand,
authorisation, direction, notice, consent, waiver or other action provided to
be made in the Agency Agreement or the Terms and Conditions of the Notes;
(ix) change the obligation of the Republic to pay additional amounts
with respect to the Notes;
(x) change this definition, the definition of “outstanding” contained in
the Agency Agreement or the definition of “Written Resolution” set out below;
(xi) change the governing law provision of the Notes;
(xii) change the courts to the jurisdiction of which the Republic has
submitted, its obligation under the Agency Agreement or the Terms and
Conditions of the Notes to appoint and maintain an agent for service of process
or the waiver of immunity in respect of actions or proceedings brought by any
holder based upon a Note; or
(xiii) appoint a committee to represent Noteholders after an event of
default occurs; (each a “Reserved Matter”), the necessary quorum will be
one or more persons holding or representing not less than 75 per cent. of the
aggregate principal amount of the Notes for the time being outstanding or not
less than 50 per cent. of the aggregate principal amount of the Notes for the
time being outstanding at any adjourned meeting. Resolutions may be duly passed
as an Extraordinary Resolution at any meeting of the Noteholders or by Written
Resolution and will be binding on all the Noteholders (whether or not they are
present at such meeting and whether or not they may sign the Written
Resolution) and on all Couponholders. An “Extraordinary Resolution”
means a resolution passed at a meeting of the Noteholders duly convened and
held in accordance with the provisions above by or on behalf of the holders of:
(i) in the case of a Reserved Matter, at least 75 per cent. Of the aggregate
principal amount of the Notes for the time being outstanding or at least 50 per
cent. at any adjourned meeting of aggregate principal amount of the Notes for the
time being outstanding, or (ii) in the case of a matter other than a Reserved
Matter, at least 66 2/3 per cent. of the aggregate principal amount of the
Notes for the time being outstanding or at least 25 per cent. at any adjourned
meeting of the aggregate principal amount of the Notes for the time being
outstanding. A “Written Resolution” means a resolution in writing signed
by or on behalf of the holders of: (i) in the case of a Reserved Matter, at
least 75 per cent. of the aggregate principal amount of the Notes for the time
being outstanding, or (ii) in the case of a matter other than a Reserved
Matter, at least 66 2/3 per cent. of the aggregate principal amount of the
Notes for the time being outstanding. Any Written Resolution may be contained
in one document or several documents in the same form, each signed by or on
behalf of one or more Noteholders.
The Republic and the Agent may, without the vote or consent of any
holder of the Notes, amend the Agency Agreement or the Notes for the purpose
of: (i) adding to Republic’s covenants for the benefit of the holders of the
Notes; or
(ii) surrendering any right or power conferred upon the Republic; or
(iii) securing the Notes; or
(iv) curing any ambiguity or curing, correcting or supplementing any
defective provision in the Notes or the Agency Agreement; or
(v) amending the Agency Agreement or any of the Notes in any manner
which
the Republic and the Agent may determine and which is not inconsistent with
the Notes and does not in the opinion of the Republic adversely affect the
interest of any holder of the Notes; or
(vi) correcting in the opinion of the Republic a manifest error of a
formal, minor or technical nature; or
(vii) complying with mandatory provisions of law or any other
modification provided that such modification is not in the opinion of the
Republic materially prejudicial to the interests of the Holders. Any such
modification, waiver or authorisation shall be binding on the Noteholders and
any such modification unless the Agent otherwise requires, shall be notified by
the Agent to the Noteholders as soon as practicable thereafter. For the
purposes of (i) ascertaining the right to attend and vote at any meeting of Noteholders,
(ii) Condition 10 (Meetings of Noteholders and Modification) of the Offering
Circular and Schedule 3 of the Agency Agreement (Provisions for Meetings of
Noteholders) and (iii) Condition 7 (Events of Default) and for purposes of determining
whether the required percentage of holders of the Notes are present at a meeting
for quorum purposes, or has consented to or voted in favour of any request,
demand, authorisation, direction, notice, consent, waiver, amendment,
modification or supplement to the Notes or the Agency Agreement, or whether the
required percentage of holders has delivered a notice of acceleration of the
Notes, any Notes that the Republic owns or controls directly or indirectly will
be disregarded and deemed not to be outstanding. For this purpose, Notes owned,
directly or indirectly, by the Bank of Greece or any of the Republic’s local
authorities and other local authorities’ entities will not be regarded as, or
deemed to be, owned or controlled, directly or indirectly by the Republic. “Control”
means the power, directly or indirectly, through the ownership of voting securities
or other ownership interests or otherwise, to direct the management of or elect
or appoint a majority of the board of directors or other persons performing similar
functions in lieu of, or in addition to, the board of directors of a
corporation, trust, financial institution or other entity. Before any request
is made or notice is delivered or Written Resolution is signed by any
Noteholder in accordance with the provisions of this Condition 10 or Condition
7, the relevant Noteholder must deposit its Notes with the Paying Agent and
obtain two copies of an acknowledgment of receipt (an “Acknowledgment”)
signed and dated by the Paying Agent and certifying the nominal amount of Notes
so deposited. Any request so made, notice so given or Written Resolution so
signed by any Noteholder must be accompanied by an Acknowledgment issued to the
Noteholder. Notes so deposited will not be released until the earlier of (i) the
thirtieth day after the date of deposit and (ii) the request, notice or Written
Resolution becoming effective in accordance with these Terms and Conditions,
and will only be released against surrender of a relevant Acknowledgment.
